A New Prescription for Taxes

By

Anna Wilde Mathews

February 17, 2013

This year, several important tax changes tied to the federal health overhaul will start affecting consumers—including new limits on medical deductions and higher tax rates for some higher-income taxpayers.

Tax advisers say consumers need to be aware of the tweaks. Some may need to take action to ensure they're complying with the new requirements or to try to reduce their exposure.

One key shift can already be spotted by many employees, though it isn't costing them money: Many larger employers now have to include on the W-2, the annual federal wage-data tax form, a figure that represents the cost of the worker's health coverage. The sum includes both the employee's and employer's contributions. It appears in box 12 after the letters DD.

The disclosure, required under the health-care law, highlights the value of the tax break given to employer-provided health coverage, the cost of which isn't counted as taxable income. Many employees don't know how much is spent on their health benefits, and the sum will be a shock to some.

Policy makers in Washington have floated the idea of capping the amount of deductions for higher-income taxpayers, a move that could limit the health-coverage exemption.

With this new disclosure, employees "become aware of how much money this is, and the impact on them if some or all of it became taxable," says Gary Claxton, a vice president at the Kaiser Family Foundation. The upshot would be to increase their taxable income.

ENLARGE

Daniel Hertzberg

Some employees already are feeling the effects of another tax change tied to the health law. For 2013, the annual contribution to flexible-spending accounts—which let you pay for qualifying medical expenses with pretax dollars—was capped at $2,500.

Some other changes may not yet be so obvious. One raises the bar for the itemized deduction that taxpayers can take for their medical expenses, a category that includes their out-of-pocket payments for things like doctor visits, prescriptions, physical therapy and hospital bills. For 2013, expenses can only be deducted if they exceed 10% of your adjusted gross income, up from 7.5% for 2012. For people age 65 and older, the 10% doesn't kick in until 2017.

The cutoff was already high, says Kristin Esposito, technical manager at the American Institute of CPAs, and "now it's going to be harder to meet that limit."

Tax experts say consumers should be careful in tracking their expenses to make sure they don't miss anything that might qualify and help them get over the threshold. Ms. Esposito says some taxpayers may also want to consider moves that hold down their income, perhaps by deferring some compensation or delaying plans to cash in an investment that would bring a gain.

The other big changes will affect individuals with adjusted gross income of more than $200,000 and married couples making above $250,000 who file jointly; for spouses who file separately, the threshold is $125,000 each. For wages above these cutoffs, taxpayers this year face a Medicare tax rate of 2.35%, up from 1.45% in 2012.

The increase comes with an added wrinkle, says Debera Salam, director of payroll information services for Ernst & Young. In the past, employers were easily able to withhold the proper amount of Medicare tax because the rate was consistent. Now, because employers won't know a spouse's income, they may not get the figure right.

To ensure the amount is correct and they aren't at risk of a tax penalty, higher-income taxpayers have "got to be proactive," says Ms. Salam, and talk to a tax adviser. Among the options: Employees can make their own estimated payments throughout the year, or file a W-4 form with the employer to request the proper withholding.

For the higher earners, the health law also includes a new 3.8% tax on unearned income above the thresholds mentioned earlier. That hits income from sources such as rent and investments, rather than wages. Robert S. Keebler, a certified public accountant in Green Bay, Wis., is suggesting clients look at investment options that will minimize the impact of the new tax, such as municipal bonds or rental real-estate properties where, for tax purposes, depreciation will likely cancel out the income.

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